did file for bankruptcy in line to be the largest u.s. city to fail with the city council halting bond payments so hurriedly talk about what is going on in muni land the risks the rewards the reality is kate long she's a guest contributor to reuters dot com where she writes the muni land column and i'm so excited to talk about this because i have to say kate we don't cover this ever so i'm so excited to have you here today. thanks so much joy yeah so let's just start with a very big picture and tell us where you are in terms of are you more with team whitney who saying they're still going to be more pain in union land they're going to be more defaults more disasters this is not going to end well or are you more in the camp of those say i'll say the david kotok camp who is someone that's been on our show who says whitney was dead wrong ok the key in the land is to do your homework and just avoid the trouble spots that i mean it's a lot of municipal bond in a list that analyzes many many credits at the individual level and then you have the rating agencies and all these folks you know generally feel the land is pretty

strong we have weak spots california as you said they've had some structural revenue problems there and there's harrisburg pennsylvania that will probably file in the next month or so detroit is the very big one but for the most part u.s. credits are strong and the yields in the municipal market are at historic lows we have massive demand so generally it's a strong bright picture but there are these kind of dark spots that are isolated but it doesn't equal what meredith whitney believes was a massive wave of defaults for for the mare for the country ok so then let's parse this out a little bit so in terms of the trouble that faces cities and also states to where are the signs of weakness the factors that are the the headwinds and what are the tailwinds for one for example we keep hearing how housing is improving i know property taxes are a huge source of revenue for cities are these improving are these not up to where they need to be or used to be i mean clearly not where they used to be but better

than better. there's they're slowly improving but the thing you have to realize with property taxes is that valuations are done on and generally a rolling three year cycle some places do it on a one year cycle so you still have a lot of leg and property valuations that are affected how much tax can be collected some cities bumped up the rates they use the mills they use and collect more but that has been a very big weak spot that's about fifty percent of local governments revenue sources property taxes generally where you see the problems are places that already have a lot of debt and generally of us bad management. in some cases states and cities issue pension bonds instead of contributing to their pension plan so they have these big lumps of pension bonds outstanding but often it's two things it's either too much debt or just very poor management. ok too much debt a story we hear all the time poor management where are these where are the real trouble spots that you're saying ok avoid these these are disasters you named

a couple but one i know that's on your radar is detroit which is a very large city i know their finances are a disaster from reading your blog so what's what's the status there. so detroit at one time had a million three people in it now has about seven hundred thousand people in it they've walked down the infrastructure size the municipal infrastructure size over the years but really hasn't been reduced enough to be able for the tax base to support it they're running the city budgets about a billion three and they're running about one hundred million dollars deficit this year they've been in a ballet with the state to get some proceeds of a bond offering that the state doesn't state did on their behalf but the city council it's been just been sort of playing games and i think the governor there is fed up with the situation snyder and they just passed in legislature a law that would. allow a municipality that's in distress like detroit to either choose an emergency

manager go directly into chapter nine bankruptcy or do a couple of steps that would allow them to manage through the you know their fiscal stress so what do you think it's going to be do you think that they're more on the path towards bankruptcy or you think they can pull it together. it's really dire there and sort of the hidden question always for detroit is there's a lot of derivatives interest rate swaps and we've had two instances where the banks have pushed them back on detroit using terminations triggers and it's in both cases been hundreds of millions of dollars of cash. she's been a big load that was not planned for and so there's a lot of sort of moving elements parts like that but detroit does not have many many solutions at hand right now other than just really massive layoffs or defaulting on their debt and it sounds like the banks made out pretty well in that scenario that they were able to get paid on on those complex derivatives swaps deals and make good on those so generally what happened in both cases is that the

city went on a payout plan with them and paid a couple million dollars a month to pay them off they didn't they didn't give them the banks the cash up front but they sort of went on a layaway plan to pay them off of the sewer does system in detroit did issue to pay off a couple hundred million dollars of her interest rate swaps to beings ok so let's talk a little bit more about who were just on let's talk a little bit more about the role of derivatives in complex instruments swaps in some of these municipalities because one big that is just lame with scandal is jefferson county and that's a county in the largest municipal bankruptcy we've seen yet this is something that is nearing settlement according to you just to give a little bit of background to our viewers about what happened in jefferson county here's a little ten second backgrounder. jefferson county problems began with a corruption plagued sewer project when billions over budget poor investments and a loss of millions in tax revenue made things even worse. ok so they ended up

filing for bankruptcy they're close to a settlement how was the settlement going to shake out in terms of bondholders taxpayers the city or the county excuse me so the bottom totals are have the bondholders will have some recovery and i think a lot of you know could be fifty percent or seventy percent of what their what their principal was but a lot of that depends on the county getting a rate increase for the sewer system through. and in the case to taxpayers their taxes are going to go up there's no question that are there to see on the sewer system and then for the county itself they've cut about a quick twenty five or thirty percent of the employees since they went into bankruptcy so the level of services in jefferson county has been decimated so decimated for taxpayers and for residents there j.p. morgan i know was instrumental in what some would argue setting the stage for their

bankruptcy j.p. morgan was involved in a bunch of complex financial products they were peddling to the county swaps derivatives in fact j.p. morgan settled in two thousand and nine with a as you see for seven hundred million dollars over say secret payments to friends of jefferson jefferson county commissioners i mean it's absurd how did you morgan make out of this deal. they will definitely be have substantial losses through the bankruptcy they've been a primary. party in the bankruptcy proceedings and they they will have losses i'm sure they reserve for it in some way but. they definitely instigated it they paid i think almost eight million dollars in bribes to get this business initially and there was just layer after layer after layer of interest rate swaps piled on jefferson county they were all very highly. so they were way off the market when they were prized was unnecessary most of it was just blue blue green just it's

a real disaster it's a real story agreed it is a disaster and j.p. morgan you're saying is going to take some losses but the bigger picture does this hurt a bank like j.p. morgan because i've seen reports that over the last few years j.p. morgan is anywhere between the top or the number three underwriter of municipal bonds so j.p. morgan shook it off ran the bankers off to did the deals and said that there were not there instances where this happened you know there's been other instances where j.p. as you know illegal things in the municipal market but they are a dominant dominant player in. the rating so they continue to bat be strong in this area just spite the egregious acts one of the things that seems to be recurring theme quickly before we go to break is that a lot of these deals are negotiated privately and do some closure requirements are not great so is this a situation that benefits banks and this does not benefit taxpayers. yeah

negotiated deals you never know whether the issuers getting you know the proper pricing when they should get the disclosure side usually comes you know somewhere within a week or two of one of the deals it's really hard you're catching up always you don't really know and the other thing to bear in mind is a lot of these issuers are just small you know local communities and you know the guys probably a schoolteacher trace that day and night he's a finance you know he's on the board that oversees this stuff and you know so there's a lot of room for the you know smaller issues to be taken advantage of right absolutely so we're going to have more about some of these issues where perhaps parties are taking advantage also the impact of the fiscal cliff more i had with kate long municipal bond writer for reuters also still ahead apple concede defeat but as the world coming to a change the map app back to google maps or at least are allowing that more on that in loose change but first the closing market numbers.

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welcome back let's continue talking about muni land because california has got a few bankrupt cities in my home state that i'm used to california being a mess but one is san bernardino and historic fight is actually going on there here's a little of the back story. in may this region have the third highest foreclosure rate in the country and should be unemployment stood at fifteen point nine percent people are not working they're not paying taxes they're not shopping they're losing

their homes or the five thousand homes that are in foreclosure. so negative economic factors needless to say drove that city in part to bankruptcy and now the california public employees retirement system better known as cal pers is engaged in an historic fight in san bernardino according to business week it's trying to rewrite the rules for bankruptcy claiming that it should get paid before almost everyone else including bondholders so let's bring back in to ask her what is at stake here so kate long it's been cast as historic what is it stake here in this cal pers fight with san bernardino well basically the question of if the pension rights or benefits of public employees are protected in a bankruptcy setting which means they would get one hundred percent on the dollar in what bond insurers are arguing is that what is owed to pensioners should be in the same way that debt is here those are all liabilities of the community and

helpers has no reason to ring sense or. protect the pension payments so what do you think would happen depending on how this ruling goes and what way to go go should. it's very it's very odd chapter nine bankruptcy for municipalities is federal law but you also have to account state law because communities are agents of the state so there's a lot of sort of odd twists and turns that are happening in this case but essentially the federal law will prevail the bankruptcy law will prevail and it's likely the bond insurers point will be. will be taken up and the pensions probably most likely somehow will be restructured. it doesn't make sense to me that cowper's doesn't just go ahead and do that i mean there is no money in san bernadino to give the say force back this hundred forty five million dollars of pension liability san

bernardino couldn't have police or anything fire department schools they would have no money so it just doesn't you know it just doesn't really make sense right everyone to get their pound of flesh that they were owed prior to the bankruptcy which is one of the tragic things about these bankruptcies is that people lose so then i want to talk about the way that the muni market or the bondholders could lose from the fiscal cliff because when you know the fiscal cliff touches everything the municipal bonds are no exemption so first before we get to fiscal cliff one of the things about municipal bonds is that there are tax exempt and the reason i understand that this is the case is because they are tax exempt that makes them appealing to investors so then that helps cities and states borrow for less because their their bonds are attractive which helps them to more easily fun the bridges roads schools that they're building or whatever is that accurate is that how it typically does work just add one carrier that is the higher the income bracket you're in the higher tax rate you're in the more evident ages it is to have that tax exemption and show to that income ok which is why perhaps it is one thing

that is on the cutting room floor in the fiscal cliff negotiations because evidently according the wall street journal this is one thing that perhaps john boehner and the white house can agree upon that for high income individuals they maybe shouldn't get this tax exemption. anymore how would this impact things will it's. very skewed to high income earners now or people in high tax brackets people at the very top get about probably twenty seven percent of the advantage the people in the one percent get about twenty seven percent my own view is that it will really not hurt the bond market the municipal market that much there is massive demand for these bonds issuers annual issuances been shrinking year by year so there's less. you know in the end i don't think it's really that big a deal personally the states are going to have to give something up i mean they they don't want federal funds coming to them cut they don't want to cut you know something has to give in this fiscal cliff play the states have to contribute

something to the to the you know to the party so you think that if if this tax exempt status of interest is curbed to an extent it's not going to impact borrowing costs for cities or states dramatically because the demand is so high for me it's going to be impacted but you see assessments that range from like ten basis points to you know one hundred basis points and you know it's a function of where interest rates are at the time and stuff the point is there's massive demand in fact many investors are cut out from dean in this market just because you know most of the bonds are flowing up to the top income brackets just the way j.p. i'm for example j.p. morgan massive underwriter a lot of those bonds go into their own clients accounts so you know if you're not a client list likely to get the bonds. or the others in the end ratings ok and just quickly before we go why have there been such demand for muni's lately because people want to shelter that having come from decks is. there yamit very avid all

right well i appreciate you being on the show thank you so when you're being here and kate long she writes to me lamb blog at reuters thanks so much. all right time now for word of the day where we break down a financial term for our smart viewer but just perhaps not the expert and today i bet you could guess it the word is done did it on municipal bonds because we're talking about them and over the past year as state debts mount we have seen a lot of back and forth over the safety of these bonds with headlines including the following could municipal bonds be the next financial titanic or minivan still safe tax free options despite doomsday talk so it sounds like this is where our guest would fall should we be worried well first how exactly do you mean

a simple bonds work i mean a simple bond is this it's a debt security issue by a state municipality or county to finance its capital expenditures ok municipal bonds are exempt from federal taxes and for most state and local taxes the two basic types are general obligation bonds and revenue bonds and just to give you a little bit of context the revenue bond secure principal and interest charges are rent such as toll roads where as the general obligation bonds are supported by the issuers taxing power now for these bonds are often referred to as muni's and they are used to fund state or local expenditures including highways bridges schools that sort of they are often bought because of their favorable tax implications as you just heard our guest said people want to shelter their money however this could change as the fiscal cliff looms both republicans and democrats have agreed to consider taxing a portion of that municipal bond interest but some argue much of the incentive for investors to buy municipal bonds is due to their tax free status and without this

municipal borrowing costs are likely to increase potentially leading to increased defaults to get a little sense total state debt reportedly exceeds four trillion dollars. the federal government point five percent of me the schools default those or the high yield junk bonds ok so that is how often they actually default yet according to a federal reserve bank of new york and a report issued this summer bond actually occur more then that woman indicated in more than you may think it said although the low default history of miscible bonds has played a key role in luring investors to the market frequently cited default rates published by the ratings agencies do not tell the whole story about municipal bond defaults for example between one nine hundred seventy and two thousand and eleven moody's reported there were only seventy one municipal defaults however the fed report which looked at a much broader sample including unrated bonds and industrial development bonds counted twenty five hundred and twenty one defaults during the same span so you

have a big difference there depending on what you're looking at now we have yet to see the reckoning and in municipal bond market many of called for in the future is up for debate depending on who you listen to but now you know a little more about how municipal bonds work. are let's wrap up with loose change dimitrios xenos so glad you're here because this is kind of a funny story we know you love apple so that's why we chose to have them following on getting off the bat i know don't tell us about it let's talk about the story apple's map application is causing users problems recently we all know about it they've been like this. after several stranded drivers had to be rescued alba was

having to fix some serious errors in this new map feature instead of directions to the australian city of milled her driver's down under we're being led to a remote state park with extremely high temperatures and virtually no cell phone reception. is a really a layer is like a really bad practical joke in that example but anyway apple had to apologize or they chose to apologize which was pretty rare for apple and late wednesday night google released their own maps app that apple is now allowing its i phone users to use so google maps is back on on the i phone i think it's pretty crazy i just think do you think it symbolic because i just feel like you never hear of this without paul not only did they concede defeat but now they really conceded defeat there like we just can't fix it and google maps and back that actually there's no question that's actually something that i was thinking about before which is that. after they got beaten by microsoft and steve jobs came back they built their

company around being the best the best software the best integrated hardware bugs the best operating system and now they're just losing because they've reached critical mass and they just cannot possibly grow anymore. i don't know if i would be critical mass in any case but it's funny because long called me before she got here and she was lost because she was looking to google maps which i was like are you sure i don't want to you can have all i wanted to so badly to be apple so that it would work they really are wondering maybe she just thought it was she said. you know i double checked it with her because i wanted to know that it worked it did not but maybe that was you know i think in general and a map here is stupid and the thing is apple tried like you are kind of authoritarian away but they always got away with it because they were also really great but then they tried to shove this on the consumer's throat and fill because they weren't as good their back and was as good as google's they had they had a their own client but then they had to go all the way and they just create a really crappy product is it emblematic of where. apple is headed ok their stock price was seven hundred two dollars a share september nineteenth yesterday closed at five hundred thirty nine dollars i

don't recall reggie corage remember we got to get him on our let's move on the talk about the fed really quickly because bill gross of pimco had this to say about their recent decision on bloomberg. if you write checks for free you know if it's costless to finance a fiscal policy that is well into deficit figures then yes that's an inflationary moment to the extent that the private sector you know gets some animal spirits. those animal spirits i don't know i don't know where are the i don't know where they are yesterday they did not arrive at all ok the market didn't really rally bond yields are actually higher and gold was really i mean the market just doesn't really seem to care about q.e. anymore if you're one that believes that the market does react to news and it's not a bunch of hooey yeah it's like the bond market has become a little and i used to worry when two thousand and eight came around i used to worry that with all this q.e. that i was going to put upward pressure on guilds on bond yields but in fact i'm sort of the believe that because the leveraging is so great or the massive debt is

so great in the private sector then that in fact of the bond buying that the fed is doing through through the treasury market it's all it's doing is it's lifting asset prices but in fact if they pulled out they wouldn't actually be propped they're actually probably the bond market in my opinion the treasury market you don't you know you lower it because it was a propping it was that they were propping the of the rest of the market would collapse and also remember these banks in the studios where people how's their money are levered so they're going to get worried where are they going to go they're going to go into the bond market to the treasury market is they know at least they'll get they can figure i was going to try to go with more and they could pay it back yeah far with a blank check as mr gross but i want to leave it there thank you so much for watching be sure to come back tomorrow and you know in the meantime you can follow me on twitter at lauren lyster you can go like our facebook page there it is you can give us feedback we will read some of it tomorrow at youtube dot com slash capital account you can watch just a h.d.d. on hulu there it is and from everyone here have a great night. live

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